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The computation of gross domestic product (GDP) has come under fresh, intense scrutiny. Stakeholders across the world are pitching for improvement in its quality & reliability.

The four major factors propelling the urge for GDP reform are: 1) persisting uncertainty over global recovery, 2) new developments in globalization of manufacturing and services, 3) widespread perception & contention among economists against GDP numbers of countries such as India & China and 4) the limitations of existing methods of estimating GDP discovered over the years.

The stakeholders pitching for GDP reforms include multilateral institutions, national statistical organizations (NSOs) and leading economists.

Reliability of GDP, which is most important macro-economic indicator of national accounts systems, is vital for managing global uncertainty. It is also crucial for government of each country to take appropriate policy action such as changes in tariff on products or tax incentives to improve the economy’s working.

Countries largely claim to be measuring their respective GDP in keeping with in keeping with System of National Accounts 2008 (2008 SNA), a global standard released by United Nations Statistical Commission (UNSC).

This Standard is an update of the previous one adopted in 1993. 2008 SNA was prepared under the guidance of five multilateral entities – the United Nations, International Monetary Fund (IMF), the World Bank, Organisation for Economic Co-operation and Development (OECD) and European Commission (EC).

There is a large body of research & empirical evidence to show that 2008 SNA needs to be replaced by a new version. Simultaneously, UNSC must provide for regular peer review of NAS of each country in the spirit of statistical audit of their respective GDP, etc.

The peer reviews should be akin to those organized by Financial Action Task Force (FATF) to assess each country’s compliance with anti-money laundering (AML) and countering the financing of terrorism (CFT) guidelines.

To know and appreciate the limitations of 2008 SNA, start with IMF’s eye-popping discovery. In a staff discussion note (SDN) released last month, IMF illustrated how GDP numbers of eight G20 countries varied widely for years 2000-15 when computed with single and double deflation methods.

Deflation is a statistical technique for adjusting GDP from current/nominal prices to constant prices.

SDN titled ‘Measure up: A Better Way to Calculate GDP’ says: “in the wake of falling commodity prices, the accuracy of GDP growth estimates in some emerging market economies have been subject to debate, in part because of the single-deflation method used to derive volume measures. A volume estimate of GDP is an essential measure of economic activity because it removes the effects of price changes. The System of National Accounts 2008 recommends a technique called double deflation. In contrast, single deflation, the deflation with a single price index, is not recommended because it fails to capture important relative price changes that can be significant and may affect the accuracy of GDP estimates.”

According to SDN, during times of major commodity price changes such as a sharp decline of the oil price, the single deflator method can produce significantly overstated GDP (and GDP growth) data in oil-importing countries. Conversely, in oil-exporting countries, single deflation could produce an understatement of GDP.

It thus recommends: “countries should take steps to adopt double deflation. When this is not realistic in the short term, countries can explore whether single extrapolation may constitute a useful improvement with relatively minimal technical requirements.”

Anyone can sense the need to revise 2008 SNA by looking at the large number of issues and research topics that that are UNSC’s Intersecretariat Working Group on National Accounts (ISWGNA) and Advisory Expert Group on National Accounts (AEGNA).

As many as 34 research topics have to be resolved by these expert panels. The notable topics include: Role of taxes in the SNA; Issues arising from a financial crisis; Measuring the output of government services; Consolidation of enterprise groups; GDP at basic prices and Income from activities undertaken on an informal basis.

As for role of taxes in the SNA; a UNSC document notes that “taxes on products are treated as a form of income in the SNA. Most economists, however, tend to regard these as taxes on consumption. This category does not exist in the SNA and nor does consumer subsidies. Taxes on financial transactions (such as taxes on issue, purchase, and sale of securities) are treated as taxes on production even though there is often no service involved. It may be appropriate to review the SNA treatment of all taxes and subsidies to ensure that these accord with users’ understanding and need, or if not that the rationale for any differences is made quite explicit and prominent.”

As regards issues arising from a financial crisis, the document explains: “a financial crisis provides a crucial test of the robustness of the SNA and the adequacy of its recommendations in situations not encountered since the SNA was first adopted. Until all the consequences of the situation in 2008 are revealed, and indeed thereafter, there will be a need to continue to examine the steps taken in response to the crisis to ensure both the steps and their consequences are adequately captured in the national accounts.”

Some experts would obviously like UNSC to take a call on accounting of unprecedented liquidity crisis on GDP that results from demonetization of lion's share of currency available with the public as happened recently in India.

UNSC’s two expert panels have also to resolve 10 issues that in addition to 34 research topics. A major issue is ‘Holding gain and loss in estimating investment income’.

According to a UN disclosure, “The 2008 SNA appears to provide conflicting guidance on whether to include holding gains and losses in the estimates of investment income attributable to insurance policyholders and pension beneficiaries that are treated as premium or contribution supplements in the calculation of the implicit service charges for insurers and pension funds. In instances where the 2008 SNA appears to recommend the inclusion of holding gains/losses in the estimates of this investment income, it is silent on whether these holding gains/losses should include only realized ones.”

It adds: “The 2008 SNA is also not explicit on whether holding gains/losses should be included in the change in life insurance and annuity technical reserves and the change in pension entitlements when calculating the implicit service charges for life insurance, annuities and pension funds.”

Another major unresolved issue is accounting of output of ‘factoryless goods producers’ (FGPs). These are producers that outsource the manufacturing transformation activities but own the underlying intellectual property products (IPPs) and control the outcome of the production process.

Let us now shift focus from multilateral agencies to national bodies and universities that are pitching for GDP reforms.

National Bureau of Economic Research (NBER), a leading, non-profit US entity, has mooted “a new and superior measure of U.S. GDP, obtained by applying optimal signal-extraction techniques to the (noisy) expenditure-side and income-side estimates.”

In the U.S., two often-divergent GDP estimates exist, a widely-used expenditure-side version, GDPE, and a much less widely-used income-side version, GDPI. A GDP estimate based on both GDPE and GDPI may be superior to either one alone.

In a working paper (WP) captioned ‘Improving GDP Measurement: A Measurement-Error Perspective’ released in 2013, NBER says: “We do not, however, advocate that the U.S. publish only GDPM, as there may at times be value in being able to see the income and expenditure sides separately. But we would advocate the additional calculation of GDPM and using it as the benchmark GDP estimate.”

It is apt here to also refer to another WP paper released by US Federal Reserve in 2015. Captioned ‘Measurement Error in Macroeconomic Data and Economics Research: Data Revisions, Gross Domestic Product, and Gross Domestic Income’ WP notes that “measurement error in macroeconomic data can have meaningful consequences on research because we find that estimating models using GDI instead of GDP can change published results. In general, we recommend that economic models should take into account when data are the estimates of the true quantities of interest, although we have no panacea on how to implement this recommendation. For the specific context of models estimated with GDP, we suggest that estimation should be robust to using either GDP or GDI as an author’s estimate of latent output.”

It adds: “measurement error in national statistics could affect economics research and we have provided a broad scope of examples to this effect.”

GDP is the monetary value of goods and services produced by an economy during a specified period, which is usually a quarter or an year. It can be estimated by three approaches- 1) expenditure approach in which all expenses incurred by final users are aggregated, 2) income approach in which all income is aggregated or 3) production approach in which value-added during production of goods and services is aggregated.

Australian Bureau of Statistics (ABS) takes average of GDP computed with three approaches. It is one of only a few statistical agencies in the world to compile and publish all three measures of GDP.

As put by three economists from Reserve Bank of Australia, real-time estimates of GDP growth are subject to significant revisions, so users should be careful not to over-interpret quarterly changes based on early vintages of data. It also highlights the importance of gathering and monitoring a wide range of other timely data and information.

In a paper titled ‘GDP Revisions: Measurement and Implications’ published during 2013, ABS economists concluded: “Revisions to early estimates of GDP growth have tended to be sizeable and in an upwards direction, though these characteristics are not unusual by international standards. Of the three measures of GDP growth, the production measure has performed as well, or better, than the other measures as a real-time indicator of the ‘final’ GDP growth estimate.”

The story of GDP errors is spread across all countries. The only difference is that the authorities in some countries are either reticent or reluctant to discuss the errors in public.

A case in point is the forthright acknowledgement of errors by a paper published by Reserve Bank of New Zealand (RBNZ) published in 2002. The Paper examined RBNZ’s forecasting performance for quarterly growth in GDP during period-December 1994-March 2002.

Titled ‘GDP Forecast Errors, the Paper concluded: “on average we have over-predicted quarterly GDP growth 4 to 8-quarters ahead. Our forecasts of GDP for these horizons have tended to be 0.25 percentage points higher than actual quarterly growth. This holds for both production and expenditure-based measures of GDP. The size of our forecast errors tends to be larger for longer forecast horizons.”

To conclude, UNSC should draw a big picture of errors and limitations in computation of GDP of each country. Simultaneously, it should compile all suggestions to improve estimation of GDP. This should facilitate development of new SNA. And it should consider advising all countries to estimate GDP by all three methods and taking the average of three set of numbers to get realistic picture of economic growth.